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Alternative investments are edging into the mainstream after years of being available only to institutional investors and the upper elite of private investors. This shouldn’t be a surprise given the market volatility of the last few years and the increasing recession predictions. However, the economy isn’t the only reason alternative investments are becoming more attractive to financial advisors and retail investors. Alternative investing continues to evolve, and today alts come in many shapes, sizes, and levels of complexity.
Let’s explore the barriers that have kept alts in an ivory tower, why they’re becoming mainstream, and how advisors and their clients can incorporate alts into their portfolios.
Barriers to alts investing
While alts are becoming more common in retail portfolios and self-directed IRAs, incorporating them still presents many challenges. Ultimately, it comes down to access.
Public, but not publicly traded
Alternative investments aren’t usually publicly traded, which means they aren’t typically available to retail investors. Investors must meet specific criteria to be eligible to invest in alts because of their complex nature, reduced regulatory oversight and degree of risk.
Following the Great Depression, the United States government introduced the Securities Act of 1933 as well as the Securities Exchange Act of 1934 to structure and regulate the securities industries. Part of the remit, of the newly formed Securities and Commission, was to protect less sophisticated individual investors who may not have the wherewithal to sustain losses from complex and/or high-risk investment opportunities they may not fully understand. Today, only accredited investors (those with the qualifications or assets to weather the risks) may invest in alts.
High cost of entry
Additionally, most alts have prohibitively high minimum investment requirements and associated fees for the average retail investor. For example, many alternative funds have a minimum investment threshold of at least $1 million, putting them out of reach for the average investor.
Why alts are becoming increasingly mainstream
Despite these barriers, alts are becoming a fixture in mainstream investing. Many factors contribute to this shift, including the desire for higher yields, market volatility, economic conditions, and perceived exclusivity.
Investors want higher returns
No kidding, you might be thinking. However, if you look at performance history, it’s clear why advisors and their clients are considering alts. According to benchmark statistics from Cambridge Associates, private equity and venture capital outperformed the S&P 500 over the past five years.
Protection in challenging markets
Although they present a greater level of risk, alts can help dampen the effects of market volatility when included in a diversified portfolio. Alts don’t necessarily move with the market and can continue to perform while traditional equities are contracting. They can also provide a struggling portfolio with yield options that might not be available to a standard public market portfolio.
The exclusivity of alts makes them appealing to ultra-high-net-worth investors. Sophisticated investors want to feel like they’re involved in something unique. For example, if a private equity opportunity is only open to 100 investors who meet exclusive criteria, those 100 investors have an edge over the millions who don’t make the cut.
As the alternative marketplace grows, so does the selection of products and asset types. Advisors have many more options to help construct a diversified portfolio representing different asset classes of just alternative products.
Finding the right custodian
Advisors who want to offer alts need to work with a custodian who can support them. However, many standard ”big-box” custodians have opted out of holding alts or providing the framework for an advisor to offer appropriate alts to their clients. Some boutique and service-oriented custodians are willing and able to hold alts and provide the structure advisors need to offer alts to their clients. Some of the features advisors should look for in an alts custodian include:
Custody of traditional and alternative assets on a single platform
Advisors should look for a custodian who embraces and understands that alternatives are more mainstream than ever. They need one-stop custody services that make it simpler for an advisor to manage and report on a client’s entire portfolio holistically. The right platform allows advisors to track valuation and performance across all holdings through a single portal, creating an overview of a client’s wealth.
Provide an experienced team
Advisors should look for a custodian whose service team has expertise in both alts and traditional investments. They should be able to answer questions such as:
- How do I get an alt approved on the platform?
- How do I purchase alts on your platform?
- How are the assets custodied on your platform?
On this note, alts shouldn’t be an accommodation. Custodians who only offer alts support as an accommodation are unlikely to have the expertise to deliver these services efficiently.
Service all alts
Advisors should seek a custodian that is well-versed in the alts space and interested in keeping up with emerging assets and developments. The world of alternative investments continues to grow and innovate. To evolve your business, be sure your custodian isn’t holding you back.
Alternative investments are moving into the mainstream, and advisors and investors are looking for ways to integrate them into portfolios. Advisors who want to offer their clients the opportunity to add alts to their portfolios need the proper support and framework to do so efficiently.
Joseph Gerdes is president & CEO of Equity Advisor Solutions.
Read more articles by Joseph Gerdes